Grand coalition in the interest rate turnaround

Talks related to the formation of a new grand coalition are in their final stages. The results of talks held so far indicate that full government coffers have awakened desires among both SPD and Union – there are plans to spend at least EUR 46bn in the coming parliamentary term. However, this generous mood could soon be brought to an abrupt end by the capital markets. The interest rate turnaround is already in full swing. Since the beginning of the year the prospect of rejection by the ECB of ultra-expansionary monetary policy has made German Treasury bond yields rise sharply. However, the political actors have not yet become aware of the fiscal consequences of rising yields and the resulting need for action.

In order to quantify the fiscal consequences of a significant increase in yield levels a comparison should be made between a scenario with rapidly rising yields (to 2.5% by 2021) and a scenario with constantly low yields (0.1%). For the latter scenario the German state’s interest expenditure is likely to amount to a mere EUR 112bn for the entire parliamentary term. By contrast, in a scenario with rapidly rising yields the additional interest burden is EUR 66bn up to 2021. This would result in budget deficits of between 0.2% and 0.3% of GDP during the overall parliamentary term.

The German federal government has apparently become accustomed to the status quo, featuring buoyant tax revenues and a historically low interest burden. The coalition negotiations are still based on the assumption that the fiscal boon provided by expansionary ECB policy will continue for ever. Thus an interest rate turnaround and its fiscal consequences are likely to be barely taken into account in the economic policy plans of the grand coalition partners. Rapidly rising German Treasury bond yields could result in the generous election gifts of a new German federal government driving the budget into deficit already this year, with the likelihood of further increases in subsequent years. Due to the still continuing economic recovery Germany’s total debt situation should also continue to be very positive in future. The times of exuberant distribution policy are likely to be drawing to a close however.

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